After the FTX crash, here’s what you need to know – the crypto bubble is already bursting | Carol Alexander

Fafter the bankruptcy of one of the world’s largest cryptocurrency exchanges, FTX, the price of bitcoin (BTC) tumbled again. It’s now around $16,500 – a far cry from the record high of $66,000 just a year ago.

Why such a large drop in value? This is due to the highly toxic combination of an exchange (an electronic platform for buying and selling) called Binance, a stablecoin (a crypto whose price is pegged 1:1 to the US dollar or another “fiat” -currency is linked) called tether, and the skilled professional traders who execute high-frequency algorithms.

Unlike stocks, bitcoin can be traded on many different exchanges, but Binance has more than 50% of the entire crypto market, and as a result, it determines the price of bitcoin and other cryptocurrencies. To buy cryptocurrencies, traders must convert fiat money into a stablecoin like tether. Bitcoin tether has by far the largest volume of any product on Binance, and because one dollar usually equals one tether, trading bitcoin tether determines the dollar price of bitcoin. But when bitcoin crashes, so does the entire crypto ecosystem.

The problem is that Binance is only self-regulated, meaning it is completely unregulated by traditional market regulators such as the Securities Exchange Commission in the US or the Financial Conduct Authority in the UK. This is a big attraction for professional traders because they can use high-frequency price manipulation algorithms on Binance, which is against the law in regulated markets. These algorithms can cause rapid price movements up and down, making bitcoin extremely volatile.

Binance does its own clearing and settlement of trades, the same as all other self-regulated crypto exchanges. This means that losing counterparties – those on the other side of profitable trades – often have their positions automatically wiped out without notice.

Unlike normal exchanges, self-regulated crypto exchanges are not required to raise an alarm when a trade has lost so much money that the collateral in the account needs to be replenished. Instead, traders are solely responsible for funding their accounts by constantly monitoring something called the liquidation price. This is done automatically by the algorithms managed by professional traders, but it is exhausting for ordinary players like you and me, who must remain highly vigilant when manipulation is used to create the volatility that professional traders use to increase their profits.

When professionals trade against each other, it is called toxic flow because the chance of profit is more like 50-50 if their algorithms are equally fast and effective. Professional traders much prefer their counterparty to be an ordinary investor.

This is worrying because Binance has been very successful in attracting ordinary investors. The fees he earns from this type of investor have financed his very rapid expansion; it is now branching out with its own stablecoin, blockchain and NFT market. Binance is consolidating its role as the Amazon of crypto, following a very effective business model.

In some ways, one can compare the current conditions in crypto markets to the bursting of the dotcom bubble in 2001-2. The venture capital that started in the Internet in 1999-2000 suddenly dried up as many companies went bankrupt. This year, Three Arrows Capital, one of the largest crypto hedge funds, defaulted on its loans, and major crypto lending companies Celsius and Voyager filed for bankruptcy when the price of bitcoin collapsed, following some unexpected and shocking attacks on ‘ a new type of stablecoin called Terra. After the bankruptcy of FTX, several other exchanges such as Gemini, and lending platforms (shadow banks) including Genesis prevent customers from withdrawing their funds.

We’ll see a lot more of this contagion, causing widespread bankruptcies among startups now that venture capital has dried up in the crypto sector. More exchange and lending platforms, as well as blockchains, NFT marketplaces, data aggregators and analytics companies will all bite the dust.

Binance can emerge from this chaos with a monopoly. But at the moment, this non-domiciled and self-regulated company still needs fee income from ordinary investors, and it needs market makers (professional traders similar to unfriendly stall holders on the stock exchange) to run its business.

The danger is that everyone is very scared now, so the only way to attract ordinary investors is to pump up the price of bitcoin again. This will lure people back into the crypto game, only to wipe out their savings as the cycle of volatility continues.

Carol Alexander is Professor of Finance at the University of Sussex and a consultant in cryptomarkets and financial risk analysis

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